Entrepreneurial Ecosystems: Irish tax / grants not key to success

Entrepreneurial Ecosystems: Policymakers and lobbyists in Ireland and elsewhere focus on tax incentives, grants and business regulations as key ingredients in promoting business startups and the number of entrepreneurs in an economy. However, this conventional wisdom is wrong in particular in the case of the small percentage of high growth firms that are key contributors to economic growth and employment in an economy.

In Ireland the people, including Richard Bruton, enterprise minister, who argue in advance of Budget 2016 on 13 Oct, for a 10% capital gains tax (CGT) rate compared with the current rate of 33%, to encourage entrepreneurship, are not basing the case on evidence — see here.

Ibec, the principal business lobby group, is seeking a 20% CGT rate for "entrepreneurs" and last August it called for Irish teachers to be trained in “entrepreneurial thinking” so it can be introduced at the earliest stage in young people’s schooling.

There would be merit in teaching for example the basics of the income tax system but teaching 5 year olds for example about entrepreneurship as The Wall Street Journal cites here in the US, is a step too far while the available evidence from third level on the value of entrepreneurship education is not compelling, according to a professor of entrepreneurship cited below.

A research paper released last week by the US Ewing Marion Kauffman Foundation calls into question the effectiveness of strategies by governments and private grantmaking focused narrowly on financing or training entrepreneurs, without regard to the broad context of entrepreneurship. In contrast with such an approach, the paper, Enabling Entrepreneurial Ecosystems by Philip Auerswald, associate professor at George Mason University, supports the view that entrepreneurs perform best in environments that are connected, dense and diverse. This approach is especially apt to bear fruit amid economic disruptions, and even during recessions, when entrepreneurial activity actually intensifies.

In our Startup Ireland article linked to above we covered the etymology of the term "entrepreneur' and Philip Auerswald cites Sir Arthur George Tansley (1871–1955), the English botanist and a pioneer in the science of ecology, who coined the term "ecosystem" in a 1935 paper, "The Use and Abuse of Vegetational Concepts and Terms."

"Our natural human prejudices force us to consider the organisms (in the sense of the biologist) as the most important parts of these systems, but certainly the inorganic 'factors' are also parts—there could be no systems without them, and there is constant interchange of the most various kinds within each system, not only between the organisms but between the organic and the inorganic. These ecosystems, as we may call them, are of the most various kinds and sizes. They form one category of the multitudinous physical systems of the universe, which range from the universe as a whole down to the atom.”

Prof Auerswald cites AnnaLee Saxenian, a professor and the current dean of the University of California Berkeley School of Information, who in a 1998 interview compared technology development in Silicon Valley with film production in Los Angeles.

She said the source of regional technological advantage lies not in vague and unmeasurable knowledge spillovers but in the highly tangible flexibility of economic actors to organize and reorganize flexibly as the need arises.

The paper says "entrepreneurs repeatedly report that conventional tools of business-friendly policy, such as tax incentives, grants, and local regulations, have little relevance to their success or to the vitality of local entrepreneurial ecosystems. Entrepreneurs instead emphasize the importance of access to networks, quality of life, and other intangibles."

Endeavor is global entrepreneurship movement and in a report published in 2014 on a survey of 150 founders, it found that "two factors that are often discussed by policymakers and business leaders — low tax rates and business-friendly regulations — were mentioned only a handful of times in our surveys and interviews. In fact, words related to specific quality of life factors, such as 'park' and 'restaurants' were discussed more frequently than terms related to taxes and regulations."

1. 80% of entrepreneurs had lived in their city for at least two years before founding their company. Close to half of respondents cited their current residence as a factor in deciding where to launch their company; 2. We believe that the magic formula for attracting and retaining the best entrepreneurs is this: a great place to live plus a talented pool of potential employees, and excellent access to customers and suppliers. According to the entrepreneurs in our study, cities that offer these resources are more likely to benefit from fast-growing companies that create jobs and increase prosperity in their communities; 3. Access to talent was not the only business-related resource mentioned by the entrepreneurs in our study. Nineteen percent of the respondents also cited access to markets, in the form of clients or suppliers, as a factor in their decision to locate their company in the specific city where they did so. This response was most common among entrepreneurs leading companies that sell to other businesses, rather than individual consumers.

Other research confirms the importance of having existing connections in a city. This is relevant for the Irish Government's efforts to attract overseas residents who are new to Dublin to launch startups there.

The Irish Government is also a provider of capital to venture capital funds but the VC model with its incentive for an exit when a startup with potential gets a buyout offer, contributes to the lack of scaleups in Ireland.

A 2013 World Economic Forum survey of more than 1,000 entrepreneurs in forty-three countries found similarly that the elements of the ecosystem of greatest concern to entrepreneurs are funding and finance, human resources, and market opportunity, with government and regulatory issues a comparably significant concern only among entrepreneurs in the Middle East and Africa.

“The paper raises questions and provides practical advice about the best way to encourage entrepreneurship, which is crucial to the growth of our economy,” said Dane Stangler, vice president of Research and Policy at the Kauffman Foundation. “It encourages proponents of entrepreneurship to take a step back and envision a more holistic approach toward accomplishing their goals.”

The most significant impediments to entrepreneurship are the everyday struggles entrepreneurs face in communicating ideas, building trust and making deals, the report argues. The prescription is for an entrepreneurial ecosystem to remove, or at least minimize, the roadblocks to those goals.

The paper recommends six strategies to create strong entrepreneurial ecosystems:

Favour incumbents less. Policies and regulations that favour existing, dominant companies over entrepreneurial ventures constrain competition and create barriers to entry for new firms. Examples of such regulations include assertive enforcement of non-compete laws, excessively restrictive occupational licensing requirements and regulatory complexity that inhibits contracting. Policymakers should avoid such policies and regulations and work to reduce the barriers to business startup.

Listen to entrepreneurs. Rather than developing policies abstractly intended to correct “market failures,” policymakers should listen to what entrepreneurs have to say about their challenges. That input should be used to develop policies that stimulate idea exploration, product development and increased rates of deal flow.

Map the ecosystem. Entrepreneurial supporters should create an inventory or graph that indicates who the participants in the ecosystem are and how they are connected. Ecosystem maps can become valuable tools in developing engagement strategies.

Think big, start small, move fast. This simple rule, long a guiding principle for entrepreneurial ventures, also holds true for successful entrepreneurial ecosystems. The ecosystem should enable the connectivity needed for early success, and then clear the runway for future growth.

Avoid artificially segmenting your community or your strategies. Entrepreneurs and members of entrepreneurial communities are active participants in creating new companies, investing in and/or advising startups, mentoring entrepreneurs and serving as customers of entrepreneurial companies. Expect participants in entrepreneurial ecosystems to play multiple roles, and make the most of their valuable skillsets.

Prepare to capitalize on crises. Much like the rotting trunk of a fallen tree feeds the growth of new saplings, economic disruption creates entrepreneurial opportunities. Because disruptions are inevitable in economic and social life, architects of entrepreneurial ecosystems should anticipate them and prepare to make the most of the opportunities they create.

The paper says establishing an entrepreneurial ecosystem requires a practical approach toward entrepreneurs’ everyday needs. Policymakers should ask relevant questions and map out a broad framework that minimizes barriers to success. Once the results are evaluated, policymakers should use that data to make necessary adjustments.

The Financial Times' lexicon says the "absolute model of a successful entrepreneurial ecosystem is the well-known Silicon Valley with its numerous and often leading high-tech companies and a very well-developed venture capital base. Many countries and regions have tried to emulate it, though often with limited success. Israel, Ireland and Taiwan also represent very dynamic entrepreneurial ecosystems. Such ecosystems have been developed for specific sectors: Germany did so in the life sciences domain with 'BioRegio,' launched by the Federal Ministry of Education and Research in 1995, which sustained vivid entrepreneurial dynamics in biotechnology and made this programme famous Europe-wide. Developing dynamic entrepreneurial ecosystems is currently one of the objectives pursued by the European Commission which, in its "Entrepreneurship 2020 Action Plan,' talks of 'creating an environment where entrepreneurs can flourish and grow' through better access to finance, better support for new businesses in crucial phases of their lifecycle, easier business transfers, or clearer and simpler regulations."

Daniel Isenberg, a former entrepreneur, who is professor of Entrepreneurship Practice, Babson Executive Education, and founding executive director of the Babson Entrepreneurship Ecosystem Project, wrote in the Harvard Business Review in May 2014: "If we’re to prevent the enthusiasm for entrepreneurial ecosystems from also fizzling out, we need to get a better grip on what the term really means." These are his tests:

"You know that you have a strong entrepreneurship ecosystem when there are more and more startups — False. There is no evidence that increasing the number of startups per se or new businesses formation stimulates economic development. There is some evidence that it goes the other way around...In fact, encouraging startups may be bad policy.

Job creation is not the primary objective of fostering an entrepreneurship ecosystem — True. Because no one owns or represents an entrepreneurship ecosystem, there can be no one objective that motivates all of the actors.

In order to strengthen your regional entrepreneurship ecosystem, it is necessary to establish co-working spaces, incubators and the like — False. There is no systematic evidence that co-working spaces contribute significantly to growing ventures. There are many anecdotes of high-growth ventures in all segments which got their starts in incubators, but there are also many more examples, less visible perhaps, of very successful ventures that made no use of co-working space.

If we want strong entrepreneurship ecosystems we need strong entrepreneurship education — False. Surprisingly, there is no reason to believe that formal education in entrepreneurship leads to more, or more successful, entrepreneurship; there is, however, some evidence that it is irrelevant. Well-known entrepreneurial hotspots such as Israel, Route 128, Silicon Valley, Austin, Iceland and others, had significant entrepreneurship long before there were courses in it.

Entrepreneurs drive the entrepreneurship ecosystem — False. This is an oft-heard statement, but there is a critical difference between being one essential element out of many — which entrepreneurs clearly are — and being the driver. There is no one driver of an entrepreneurship ecosystem because by definition an ecosystem is a dynamic, self-regulating network of many different types of actors.

Large corporations stultify entrepreneurship ecosystems because they prey on entrepreneurs and their ventures — False. Of course, many large corporations do indeed take defensive action against entrepreneurs who challenge their markets. But it is not possible to have a vibrant entrepreneurship ecosystem without a broad spectrum of business 'flora and fauna.' This is true for a variety of reasons, two of which are: (1) corporations are important customers and market channels for entrepreneurs, not just competitors, and (2) flows of talented executives to and from larger corporations feed entrepreneurial success.

According to entrepreneurs the top three challenges everywhere are access to talent, excessive bureaucracy, and scarce early stage capital — True. But this does not mean that they are right. Whether in Boston, Tel-Aviv, Reykjavik, Milwaukee, St. Petersburg, Johannesburg, Buenos Aires, Rio or Bogota (all places where I have conducted workshops and have conducted informal surveys on the question) raising capital, finding talent, and overcoming bureaucracy are three of the top challenges entrepreneurs ascribe to their environments.

Banks are irrelevant for the entrepreneurship ecosystem because they don’t lend to startups — False. Yes, it is true that banks don’t, and shouldn’t lend to startups. That is not the business they are in. Yet banks, even if they never directly engage or interact with entrepreneurs, help financial markets mature and indirectly impact the entire value chain of investing.

Family businesses squash entrepreneurial initiative in order to protect their “franchise” — False. I have heard it said by well-known promoters of entrepreneurship that family businesses achieve scale or maximize their contribution to open markets while remaining family businesses because they, for the most part, achieve their growth through special connections and protections. Yet experience in even the most advanced economies (e.g. Denmark) suggests that corporations with ownership structures from family to public to cooperative are essential to, and highly facilitative of, the entrepreneurship ecosystem."

This is a graphic illustration of an entrepreneurship ecosystem by Prof Daniel Isenberg

Prof Isenberg has said: "Scalingup is vastly harder than startingup. What is much more certain is that, as anyone who has tried, as I have, can tell you, starting up a venture is just the first baby step on a long hard trudge to scaleup. But without the ability to scale way beyond start, all the blood, sweat and tears (and money) will be flushed right down the drain."

Less than 4% of UK startups have 10 or more employees 10 years after their creation according to a report on scalingup companies that was commissioned by the British government. However, the fastest growing 6% of businesses between 2002 and 2008 created half the new UK jobs in that period, according to data from Nesta, an innovation think-tank — Finfacts: Startups vs Scaleups: 4% of UK startups have 10+ employees 10 years later